The Financial Alchemy That’s Choking SunEdison

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CreditHarry Campbell

By Steven Davidoff Solomon

March 15, 2016

If SunEdison enters into bankruptcy, the autopsy will no doubt reveal a suicide, finding the solar energy company done in by financial engineering that was too clever and by a failure of its executives and investment bankers to remember the lessons of the financial crisis.

SunEdison is not dead yet, but it is floundering. The immediate cause of its distress is the now-terminated agreement to acquire Vivint for $2.2 billion that was struck last July.

The highly leveraged deal flashed caution from the start. SunEdison agreed to acquire Vivint Solar, but could not afford to pay the $2.2 billion. Instead, the deal consisted of cash and SunEdison common stock. SunEdison did not have the cash so it arranged to borrow $500 million from Goldman Sachs Bank USA. That was not enough so SunEdison also agreed to issue $350 million in convertible notes to Vivint holders, debt instruments that SunEdison would pay out later at 2.25 percent interest. This type of self-financed debt is the last resort of acquirers.

But it was still not enough. SunEdison had also engaged in a bit of prior financial engineering, creating two “yieldcos.” A yieldco is a bit like a master limited partnership, or M.L.P., and rides the Wall Street trend of trying to disaggregate assets while juicing returns and trying for a bit of tax arbitrage at the same time. In other words, like M.L.P.s that are now piling up as dead carcasses in the oil depression, they probably should not exist in this form. Yieldcos are newly created public companies that purchase energy assets, such as solar generation plants, from a parent company. The parent company then focuses on building these assets and can then offload them to the yieldco. The yieldco will then run the asset with the intent to create a steady stream of dividend payments to holders. And because the yieldco is a corporation and not a partnership, it can attract a wider array of investors.

One of SunEdison’s yieldcos is TerraForm Global, for acquiring solar assets in emerging markets; the other is TerraForm Power, for assets in developing markets. As part of the acquisition of Vivint, TerraForm Power agreed to purchase $922 million of Vivint assets from SunEdison. TerraForm Power would sell stock in the market to finance this acquisition.

This arrangement caused SunEdison’s first problem. SunEdison controls these two yieldcos but does not own a majority interest. And both of these yieldcos had become hedge fund hotels chasing this high yield. Indeed, SunEdison itself has attracted major hedge fund investment; David Einhorn’s Greenlight Capital owns 6.8 percent.

This is where things started to go awry.

David Tepper’s Appaloosa Management protested about the acquisition, asserting that SunEdison had used its control position to force TerraForm Power into this deal.

The price of oil collapsed also, and with that, investors drove down the stocks of solar power companies. SunEdison itself was particularly vulnerable, as it had financial statements that Greenlight itself had described as being “hard-to-decipher.”

SunEdison is already highly leveraged, with $11 billion in debt, and it runs losses, giving it little room to maneuver. More important, the two TerraForm stock prices declined precipitously, making it difficult for TerraForm Power to raise money to purchase Vivint assets.

SunEdison had a case of buyer’s remorse while the TerraForm Power board openly talked of trying to get out of the deal. Moreover, a still-unexplained delay occurred when SunEdison announced that it could not complete its annual financial statements. A delay in completing audited financial statements always creates trouble and often ruins a stock. But in this case, the problems were worse, since SunEdison needed those financial statements to register with the Securities and Exchange Commission the shares being issued to Vivint shareholders. Meanwhile, oil prices kept going down, taking SunEdison and its yieldcos with it.

Vivint was now faced with a hard choice: whether to sue SunEdison or renegotiate. In the face of a declining market, Vivint decided to cut the price its shareholders would receive. Blackstone, the owner of 77 percent of Vivint, also agreed to offer financing. The deal was adjusted so that S.E.C. registration was not required.

But unfortunately, for whatever reason, SunEdison has not finished its financial statements. Its lenders, now skittish, pulled their financing. Left with no funds and no current financial statements, SunEdison went dark. Its stock now trades in the $2 range, down from about $31 a share at the time the acquisition was announced.

A representative of SunEdison declined to comment. Representatives of Vivint did not respond to requests for comment.

Now Vivint, left waiting, has terminated its agreement and sued SunEdison for damages in a Delaware court. It’s a good case for Vivint. The agreement allows for Vivint, in the case of a willful breach, to sue for the full benefits of the transaction, which in this case are well over a billion dollars. While SunEdison can argue that this was not a willful breach, it will have a hard time.

What is SunEdison’s strategy? No doubt it is the bankruptcy one. With so much debt and little equity — its market capitalization is only $600 million despite having $2.4 billion in cash — if SunEdison declares bankruptcy, Vivint will face a drawn-out process and may find that the cash evaporates. Meanwhile, Greenlight is desperate to salvage its investment and has taken a board seat.

SunEdison is looking to settle this, no doubt for a few hundred million dollars.

What a mess.

It is important to place blame here. As for the hedge funds, like Valeant they can be dismissed for chasing a bubble deal and yield yet again. (After the Valeant crash, this is a worrying trend.)

But five large investment banks were involved in advising the parties here. Bank of America Merrill Lynch was the main adviser to SunEdison, while Goldman Sachs was also an adviser and provided financing. Barclays and Citibank advised TerraForm Power, while Morgan Stanley advised Vivint.

Even with all this firepower, it appears no one said at the beginning that such a highly leveraged acquisition with so many moving parts might create a problem. This is the old Wall Street, where someone can move a percent on the spreadsheet in terms of leverage and it is all fine. But no one, it appears — not the bankers who financed this, let alone the companies’ officers — took a step back and said that maybe this type of structure did not make sense in a post-financial crisis world.

The oil collapse might have been unforeseen. But looking at the SunEdison structure — three public companies, enormous debt and the use of various securities to buy this company — one should have questioned the arrangements. This is even before addressing the issue that Vivint is in consumer solar, an industry very different than that of SunEdison, which builds massive plants. It was a risky transaction across the board.

Will Wall Street and corporate America ever learn?

Correction:

An article on the DealBook page on Wednesday about the financial troubles of the solar company SunEdison misidentified the SunEdison affiliate that the hedge fund Appaloosa Management claimed was forced to acquire assets from SunEdison. It is TerraForm Power, not TerraForm Global.

Steven Davidoff Solomon is a professor of law at the University of California, Berkeley. His columns can be found at nytimes.com/dealbook. Follow @stevendavidoff on Twitter.

A version of this article appears in print on , on Page B7 of the New York edition with the headline: The Financial Alchemy That’s Choking SunEdison. Order Reprints | Today’s Paper | Subscribe